First-time Buyers Move To Interest-only Mortgages

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BOE, trickle up rates (with simultaneous promises of peak rates and lower inflation over the horizon) is causing fear/greed driven mayhem and only prolonging and exaggerating what is going to be and extraordinary crisis - this will go down in history as the most appaling and short-sighted spell of banking and monetary oversight this country has ever seen.

More than a quarter of first-time buyers are now opting for a interest-only mortgages because monthly repayments work out on average more than £200 cheaper.

After Gordon Brown announced measures to tackle Britain's housing affordability crisis last week, figures from the Council of Mortgage Lenders (CML) reveal that 7,000 first-time buyers took out a mortgage on an interest-only basis in May without declaring how they would pay the capital off at a later date. This number has risen from 5,000 at the beginning of the year and is almost double the number that took these types of loans out three years ago.

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BOE, trickle up rates (with simultaneous promises of peak rates and lower inflation over the horizon) is causing fear/greed driven mayhem and only prolonging and exaggerating what is going to be and extraordinary crisis - this will go down in history as the most appaling and short-sighted spell of banking and monetary oversight this country has ever seen.

I agree - lenders lost their grip on responsible lending when they stopped taking the details on the investment policy that was being used to cover the IO mortgage and when they started lending 4.25 joint income up from 2.5 joint income.

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I agree - lenders lost their grip on responsible lending when they stopped taking the details on the investment policy that was being used to cover the IO mortgage

That's a hangover from the endowment mis-selling issue. In fact, banks lending IO mortgages go out of their way to have nothing to do with your repayment vehicle whatsoever.

If a bank was to ask for details, it could be argued that they would take on the responsibility for it being sufficient to pay the mortgage off at maturity, and because they don't want another endowment fiasco on their hands they stay well away from even mentioning it.

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This article was was posted by an insightful HPCer some time ago but it deserves a second outing.

Bare in mind it was written by David Stars who isn't exactly a financial novice.

You could walk up to a guy with a spider’s web tattooed on his neck and offer an unsolicited critique on his selection of face studs, or you could invest in property; in either case, the result will be painful.

Right now, the world economy is like Wile E. Coyote when he’s just chased Road Runner off a cliff; only his disbelief keeps him hovering, defying gravity itself.

After the 9/11 terrorist attacks, US Federal Reserve chairman, Alan Greenspan, flooded the world with money and the UK followed suit. This may have been a decent strategy at a time when the world economy was under threat and they reckoned stuffing loot into our pockets would take our minds off the bogey man; but they forgot to turn off the tap.

Almost six years later, our central banks are still pumping vats of cash into our economies. These massive levels of liquidity are laundered via that gargantuan money-creation scheme known as the property/mortgage market.

Of course, many people would say I’m completely wrong about all of this. In fact, it’s really only me showing my ignorance. Take, for example, the good folks at the recent “Great Housing Debate“, run by PR consultancy Wrigglesworth. “House prices look set to continue to rise at an unstoppable rate for the foreseeable future, experts have said.”

That headline on aboutproperty.co.uk put paid to my ropey theories all right.

But, not content with foreseeing the foreseeable future, aboutproperty went on. “At the Great Housing Debate… lenders, economists and housing industry experts agreed without major economic decline house prices would keep rising.”

They continue: “‘A serious correction in the housing market traditionally occurs as a result of a sharp economic downturn, which looks extremely unlikely. It would take a reversal in recent increases of income multiples or a considerable tightening in lending criteria by banks, for there to be a serious downturn in prices,’ commented Nigel Terrington, Paragon Mortgages chief executive.”

Don’t you just love the property market? It never goes down, it always goes up forever.

The chaps at “The Great Housing Debate” even had a proper expert to explain it all. “Our expert, David Miles, Chief economist at Morgan Stanley said: ‘Public expectations regarding house price growth is key to the market's stability. Growth would need to fall successively for a number of months before peoples’ expectations, and therefore prices, were seriously impacted.’”

And finally, just in case we didn’t get it, they finished with a bit of financial voodoo: “…experts also agreed keeping homes affordable would be down to offering mortgages with more income multiples. ‘Focusing on income multiples alone is not helpful – they must be considered instead in the context of affordability,’ said Michael Coogan, director general of the Council of Mortgage Lenders. He added ‘income multiples of six or seven could be a possibility in future.’”

So, what they’re saying, in other words, is that the price of a home itself has become irrelevant in the property market as long as the means exists to match it. That doesn’t seem a sustainable basis for rising prices – but then what do I know?

Our friend from Morgan Stanley is spot on about one thing: buyer sentiment - let’s call it the Coyote effect - is all that’s levitating the property market. There’s no chance at all that legislation will be put in place to curb the enthusiasm of bankers; multiples will continue to rise and lax lending standards will persist until bad debts overtake profits and the whole house of cards is revealed.

When I stare into the sheep’s entrails in front of me I see over a thousand City wags awarding themselves over a million pounds apiece in bonuses for being so clever. I see central banks pumping massive liquidity into a war-torn world where the price of oil can go into the sky and beyond without apparently affecting inflation. I see a media that believes it’s reporting on the property market when it provides a daily platform for vested interests to talk it up.

It’s as if all the problems in the world are hidden under a great pile of money. Homeowners are rich! The meek have indeed inherited the earth. Where do I sign?

Because our political and financial betters refuse to let the air out slowly (it’s hard to pull your snout out of the trough when things are good) they will make the market crash, as they always do; for a market in economic equilibrium is hard to make windfall profits out of. Only by whipping markets into a crazed frenzy can exceptional profits be made with relatively little effort.

All of the arguments about houses having more intrinsic value than say for example, tulip bulbs or domain names are true. People need a place to live, bricks and mortar and all that. But when the money supply starts to falter, and it surely will, all hell will break loose and the little people will find that they aren’t rich after all. The money they thought they had will evaporate into last year’s City bonuses and someone else’s villa in Estonia. Some could save themselves by selling-to-rent now; but they won’t.

Every time there’s a crash of any kind in any market the professionals spend a lot of time whining that the amateurs are the ones who are spooked into selling. This is not and has never been true. The little people, unversed in the vagaries of high finance, always try to stick it out. This time it will be the same.

Mervyn King, the Bank of England governor said earlier this year (with the consumer price index (CPI) bursting from its corset at 3.1% and the retail price index (RPI) at 4.8%, both in an uptrend) that he expected inflation to ease back later this year. But he also said, in the Bank of England inflation report published a mere six months ago, that he expected inflation to ‘drop back’ to ‘target rates’ (2%) by mid-2007 (so he’s already out by around 50% on his previous ‘expectation’). And now he’s one of the ones pushing hardest for rate hikes.

There are only two blunt monetary instruments economies can use to ‘control’ inflation. They can raise interest rates to try to make the currency more attractive to hold, or they can plug up or throttle back on the money supply, thereby increasing the perceived value of the money already in circulation. But while the Bank of England has raised interest rates incrementally, the cash is still gushing forth along the river M4. (M4 is the sum of all money in circulation in the UK plus bank and building society accounts: our collective wad, if you will.)

And as long as the money supply keeps raging forth a significant subset of the working population, choking on cheap money, will hold onto their “Naked Options” (because this is what interest-only mortgages are, as I‘ll explain in a moment) to the death in the belief that they’re trying to save their homes. But many never had homes to save in the first place. It was all smoke and mirrors. They borrowed to buy one of the riskiest financial instruments yet conceived in the belief they were actually buying property. They were not. But they don’t know that… yet.

What am I on about? Surely, as anyone will tell you, an interest-only mortgage is a simple loan. It’s not the kind of esoteric financial instrument that, mishandled, could rip through the world economy like a cluster bomb. You just go down to the local estate agent or bank or broker or ice cream shop or one of 8,000 or more ‘sources of capital’ who will smile at you like a potential life partner, do a deal and you pay amount X every month for Y years. Nothing complicated about that, is there?

Well, actually there is. An interest-only mortgage carries with it the possibility of at least two sources of serious trouble. Both interest rates and the underlying house price can potentially bite you in the backside. And the proliferation of such mortgages represents a real threat to the financial system.

Even if you can get an impossibly low interest rate (Rl) and unbelievable multiples (Mh) so that you can afford the half million or so for that trendy, ex-council two-bed in Clapham (whoops; Tooting), the chances are that this low interest rate requires a low-inflation environment (in which to exist). So in other words, when the time comes to actually pay for the house at the end of the mortgage, the ‘principle’ (P) will be high in real (adjusted for inflation) terms. In other words, if your payments have stayed low, the end result will be an unaffordable bill to pay for the actual house itself.

If, on the other hand, interest rates head on upwards (Ru), the real value of the principal (at the ‘end’ of the mortgage) will be easier to meet (inflationary erosion and all that). But the mortgagee may feel as regretful as a dog when their actual monthly mortgage payments stay in the sky long enough to strip them of possibly everything they own. So, in this twisted economic world of mine high is bad and low is bad. But how can that be?

Well, here’s the answer: go down to the City of London or Wall Street and ask someone in a suit whether borrowing serious multiples of your projected pre-tax income to bet on a single investment idea is a viable strategy and they might ask how you escaped from the head-trauma ward.

Pumping vats of liquidity into the world financial system is more like religion than economics. It is the end result of a theory that believes economic expansion is something we can control by constantly expanding. And we can, if by control we mean keep it going until we can’t keep it going anymore (which seems to be what our pals at the Great Housing Debate think).

There is a yawning gulf between the knowledge required to understand interest-only mortgages and the knowledge of actual home buyers. Most people, even if they studied for years, couldn’t care less anyway; which is why they’re easy to sell in the first place. Putting these things in our hands is the equivalent of putting Homer Simpson in charge of a nuclear power station: Mostly, it’ll be okay. We might never see a meltdown at all if our luck holds out; but that would be extremely unlikely. Credit simply cannot expand indefinitely. There’s no need to foresee anything at all to understand that it’s all just a matter of time.

This is not about foreseeing the future; which is not possible, no matter the language within which such claims are couched nor the status sphere within which such claims are made.

It is about inevitabilities.

David Stars is a former currency strategist who correctly predicted the Asian currency crash. He is currently building an artifical intelligence system to trade the great depression that he believes lies ahead.

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That's a hangover from the endowment mis-selling issue. In fact, banks lending IO mortgages go out of their way to have nothing to do with your repayment vehicle whatsoever.

If a bank was to ask for details, it could be argued that they would take on the responsibility for it being sufficient to pay the mortgage off at maturity, and because they don't want another endowment fiasco on their hands they stay well away from even mentioning it.

I guess they will just take out another mortgage to pay back the same amount as they owed 25 years previous.

The other problem with IOs is that they leave the mortgage holder extremely sensitive to interest rate changes for the entire period, whereas with a repayment mortgage the effects of higher IRs lessen as you get into the later years.

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this will go down in history as the most appaling and short-sighted spell of banking and monetary oversight this country has ever seen.

Nothing short-sighted about enslaving a whole generation with massive levels of debt which they'll carry on their backs all their lives. It's a very long-sighted way of making sure there are always enough people who have to do their master's bidding.

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Nothing short-sighted about enslaving a whole generation with massive levels of debt which they'll carry on their backs all their lives. It's a very long-sighted way of making sure there are always enough people who have to do their master's bidding.

This is exactly what I was thinking last night but was too tired to articulate it and post.

I'm genuinely beginning to feel that this was the plan all along (puts tin foil hat on). Force us onto 25 year IO mortgages (effectively 25 year rental agreements with you being responsible for the maintenance).

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Sad, mad, annoying & laughing? Ohh well I give up! those muppets deserve a good lesson which they will learn.

This was me 20 years ago hadn't got a clue about mortgages. I just thought that you paid up for twenty five years , and that was that. I think it was all in the small print,and which twenty something reads all that guff? Found out load and clear though later on.

I feel sorry for these poor kids, so desperate to have a home of their own-like there's something wrong with that, and they buy into a world of hurt.

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Exactly the problem - They never make any in roads into paying the lump sum that they owe. Clever wording to make it easier to trap more vulnerable and desperate buyers.

You guys are sensationalising this somewhat. While there are some people out there who really don't appreciate that they're only paying interest on their loans, I think most with IO mortgages are perfectly aware. There are many who make lump sum payments off their mortgages.

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For ******'s sake, it seems that you CAN fool all of the people all of the time!

Interest only is interest only. It is not buying.

Interest only is interest only. It is not buying.

Interest only is interest only. It is not buying.

I see . . . well in that case I figure I should give my lender the large profit from the timely sale of my flat seeing as, if you people are to be believed, I'd been completely misled all along about my IO mortgage and in actual fact, they were always the owners and I was only ever renting . . .

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Home owners are waiting for wage inflation to kick in to erode their debts. Without inflation, mortgages remain a mill stone around the borrower's neck. So far, wage inflation has been subdued. If it does pick up however, we can expect to see interest rates start rising again. It is a lose/lose situation for borrowers. There is only one moral in this story; don't get into too much debt. It is a lesson that people have been taught since we were trading in cowrie shells and people still don't learn.

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I think this is the point. It needs to be sensationalised to counter the benign (it’s cheaper!) but insidious method of selling IO loans, ie where it is being sold to employees. IO loans are good for short term periods and where the borrower can pay off large tracts of the loan, e.g. self employed with variable, but high, cash flow. For anyone else it doesn’t appear as cost effective. IO loans have been great for the period where capital appreciation exceeds interest payments, but that diminishes as prices increase (and rates rise). I hadn’t realized though that it is just as bad if inflation doesn’t erode the capital, e.g. the low inflation example given by dstars. It’s clear to me that over the next five years we are going to see a lot of keys being dropped off at the banks as these buyers simply walk away from their increasingly unaffordable debts.

It would be great if someone could upload a spreadsheet that calculates the pros and cons of interest vs repayment including all the peripheral costs, e.g. service charges, maintenance, insurance, etc. Does this exist already?

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Interest-only mortgages are very complex, hybrid, options. They are not 'mortgages' in the sense that we tacitly understand the word. Buying an interest-only mortgage is buying the right to buy - nothing more. The time that these products are expected to survive makes them seem almost impossible (to me). They can only exist within a very small set of environments (and make sense). These thing are about to rip through our economy like economic cluster bombs.

People who believe themselves to be house buyers are borrowing mad amounts of money to purchase these options.

The article graciously posted by "Peter &..." was the version that was gelded by MoneyWeek.

I did post the original here somewhere and in it you can find out how scary these things are, both for the 'purchasers' (of the options) and for the rest of us.

My belief is that this kind of lending, coupled with the securitization of debt in order to provide a conduit for a dangerously expansive money supply, will certainly lead to enormous upheaval in the financial markets followed by a housing crash followed by a recession that will most probably lead to a great depression (for those with the power to act either misunderstand everything or this is all deliberate.)

For the whole drama to fully unfold we need to see some kind of 'unforeseeable' event that will start to incinerate much of the excess capital within the system. The best bet for this right now seems to be the demise of the artificial 'hedge funds' that were set up to hold CDOs and the like.

But it could be an earthquake or a flood or a storm or a death or another crash or simply ratings agencies forced to re-rate debt.

But it doesn't really matter; something will happen that urges banks to stop throwing big money at people. When this happens everything goes into reverse, and it will be unstoppable.

Just as the rise of the housing market has been so powerful as to bewitch us all into believing that 'property' is impregnable, in time we will all be wondering how we ever thought property was safe.

This, or a variation thereof, has happened many times in the past. Everything is in place and it has already started.